Tennessee’s revenue grew this year, despite dire predictions. But a drop is coming, experts warn

Tennessee slashed new spending this summer, canceling $1 billion worth of programs, halting state employee and teacher raises and shelving plans to extend healthcare coverage to poor new mothers and invest in students’ mental health.

The economic uncertainty was unprecedented. The predictions were dire.

Gov. Bill Lee’s office and the legislature braced for a half-billion dollar deficit as the 2019-2020 fiscal year came to an end in June, projecting another $1 billion revenue shortfall over the next year.

When the final tax revenues came this July, however, the grim estimates about the past several months proved too extreme.

The state brought in about $480 million more than budget experts had anticipated during the throes of coronavirus shutdowns, surpassing last year’s revenues by 2.4% despite historic unemployment rates. 

But if there’s anything to learn from history, the revenue collapse is likely still forthcoming, some experts caution, as federal stimulus benefits wane and Tennesseans begin to actually make cuts in their spending.

“My advice to the state would be to err on the conservative side here,” said Bill Fox, director of the University of Tennessee’s Boyd Center for Business and Economic Research, who is frequently consulted by the state for revenue forecasts. “Because the capacity to keep spending is not likely to be sustained to the same extent by the federal government.”

Fox noted that this spring and summer has proven to be unlike other recessions due to the unprecedented amount of federal aid quickly distributed across the nation.

“The way we expected taxes to react much the way they do in other recessions simply didn’t happen here,” Fox said. “The reason for this is is because people didn’t reduce their consumption as much as they shifted their consumption.”

While Tennesseans cut back on dining out, gas, hotels and purchasing other services, they found new areas of spending, racking up higher grocery bills, shopping online and splurging on recreational items like bicycles and kayaks, which retailers couldn’t keep on the shelves. All of those spending categories are subject to sales tax in Tennessee.

That consumer behavior, despite thousands of Tennesseans left out of work, was made possible by federal unemployment supplements and $1,200 stimulus checks for each adult.

But going from more than four months of individuals receiving $600 in additional federal unemployment benefits to the current plan of an extra $300 — which is expected to last only several weeks this time — will change spending, and in turn, state revenues.

“Instead of paying out $150 million a week for the last 17 weeks, we’ll pay out $75 million a week for six weeks,” Fox said. “Those are big differences for how much income is out there for people to spend. The reasonable view is that consumers draw back some.”

Additionally, the state is already building in a roughly $50 million reduction in revenue from the Hall Income Tax, a tax on certain investment income that has been gradually reduced in recent years. The legislature in June approved final phase-out of the tax, eliminating it for the current fiscal year.

Decline expected this year, though not as severe as past recession

Finance Commissioner Butch Eley still believes the conservative estimate of a half-billion dollar deficit for this past year was the right approach.

Eley said the drastically different revenue outcome doesn’t cause him to second-guess the state’s approach to budgeting, but rather makes him “hopeful” about how severe declines will be next year. Much of the reason Tennessee still increased revenues more than 2% over last year was because of the growth experienced during the first three quarters, Eley noted.

Had the pandemic not occurred, according to Tennessee budget documents, the state would likely have seen a more than 7% growth in tax revenues at the end of the fiscal year, projections that had led Lee in February announce major spending initiatives for education and other areas.

“We’ve still got to be very cautious,” Eley said. “There’s no doubt that where we are today is the most uncertain economic environment that we’ve ever had.”

Despite some educators, such as former teacher and Rep. Gloria Johnson, D-Knoxville, suggesting another special legislative session be held to restore $117 million in teacher raises and a $250 million school mental health trust fund that was cut from the budget, Lee said he won’t take that approach.

“It’s not logical at this point in the recession to start spending dollars that we’re not assured we’re going to have,” Eley said. “We can always adjust the levers, but we can’t ever go back and collect dollars that we don’t have.”

While Fox is still bracing for a revenue decline this year, he believes the drop won’t be to the same extent the state experienced in the last recession — an 8.5% decline in tax collections in 2009 after a 1.2% increase in 2008 — or even as dramatic as he suspected earlier this year.

Senate Minority Leader Jeff Yarbro, D-Nashville, maintains it was the wrong decision for the legislature — which passed an emergency no-growth budget in March before amending it in June with further cuts — to remove spending in areas like education and healthcare before knowing the full economic picture.

Among other programs cut, the legislature removed funding to expand TennCare coverage for low-income new mothers. The state had planned to extend postpartum benefits after seeing an average of  one new mother die each week in 2017 once their TennCare coverage ended.

“There was reason to be cautious at the time,” Yarbro said. “But we shouldn’t have been so quick to make budget decisions that can be felt in people’s lives and are going to be potentially harmful to the economic recovery.”

State braces for effects of recession to lag

A few months of better-than-expected revenue collections does not mark the end of the state’s economic woes.

During a meeting last week with Eley and others overseeing the state’s spending, Tennessee architects sought to convey to finance officials that the start of the new year in January could likely mark declines for the construction industry.

When commercial and industrial architects see demand for their work begin to dry up, the outlook usually isn’t positive for construction. And so far, that’s what has been the case for Tennessee architects in recent months.

“A lot of people consider architects the canary in the coal mine,” said Bob Franklin, president of the American Institute of Architects’ Tennessee division.

“There’s a huge industry below us that has not experienced it yet. They still have a lot of work, but it’s only a matter of months before they wake up and realize their backlog is running out. They realize there are no new projects to bid.”

Franklin, an owner of Franklin Architects in Chattanooga, on Friday stopped by the city building in Athens, where his firm had placed a bid for a municipal renovation project.

An employee in the purchasing department, creating a list of all the proposals the city had received by the deadline, was stunned to see they had received 18 bids. Nearly every architecture firm in Knoxville and Chattanooga had put in for the project, which would typically have drawn only three or four proposals due to the size, the city employee told Franklin.

“There’s very little work out there on the horizon,” Franklin said.

Among national economic indicators is the Architecture Billings Index, which can provide a prediction of what demand will be like for commercial construction activity around nine months down the road.

After the ABI’s most dramatic drop in history in March, it continued to fall. The current rate remains in a state of declining growth.

While budget preparations will be ongoing this fall, Fox believes more time to see how the economy unfolds in the coming months will help the governor’s office and General Assembly have a clearer picture of how to plan ahead for the 2021-2022 fiscal year.

He anticipates revenue this fiscal year will be lower than last year.

But only five months in to the pandemic economy, the situation could be much different in either direction in another six months, when Lee unveils his next budget.

“Once you spend the money, you can’t unspend it,” Fox said. “If you get to January, February, March and clearly the fiscal position is better, you can always say ‘Here are some things we really wanted to do. Now we can do them.'”

Reach Natalie Allison at nallison@tennessean.com. Follow her on Twitter at @natalie_allison.

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